An Introduction to Automated Market Makers

Automated Market Makers (AMM’s) provide a simple mechanism for users of DeFi platforms to trade assets and provide liquidity. In this article, I will cover how these mechanisms work, the economics that back them, and some of the subtleties of their operation.

In a prior article we discussed order books and how they are a mechanism that allows two parties to trade a pair of assets. We also discussed the concept of liquidity and how it represents how much of an asset is available to be bought or sold for a given price.

All exchanges (whether they be centralised or distributed) wish to have high liquidity so as to guarantee good prices to participants, and to reduce slippage. In order to facilitate this, most exchanges will have participants who take the role of market makers. A market maker is a participant who’s main goal is to provide liquidity, and quote on both sides of the book to facilitate this.

Market makers are commonly found on centralised exchanges. Such exchanges will provide API access so that these participants can easily connect to the exchange, and use sophisticated programs to quote for various products or pairs. Market making can be quite complex, and often involves changing your quotes rapidly when reacting to market movements, and other conditions. As such, to make a market on a regular order book requires the market maker to make a lot of rapid updates (100’s per second in some cases) in order to keep up.

Leave a Comment